Investment Strategy Conference - October 21, 2017

High Current Valuations &

the Case for Active Management
 The Secret to Investment Success 3

Buy Low, Sell High

What we should do Reality
 4

Price is what
you pay, value is
what you get.
 5

When it comes to investing, our emotions tend

to get the best of us

FEAR

Source: Bloomberg
 6

GREED

Source: Bloomberg
 7

GREED

Source: Bloomberg
Valuations: How to Determine the Highs and Lows
8

In the short run the market is a voting machine,

but in the long, it is a weighing machine
~Benjamin Graham

Source: https://rochemambolo.wordpress.com/2017/02/19/voting-vs-weighing-machine/
 9

Voting vs. Weighing Machines

Source: JPM Guide to the Markets (4Q 2017)

Voting vs. Weighing Machines
10
 11

A Historical
Look at
Buying Low vs.
Buying High

Source: Doug Short, Advisor Perspectives

How high are
12

Be fearful when others are greedy

we currently? and greedy when others are fearful.
~Warren Buffett
 The Buffett Indicator - Market Cap to GDP 13

Market cap to GDP

is probably the best
single measure of
where valuations
stand at any given
moment.
~Warren Buffett
 14
Household Equity Values Relative to GDP Now Exceeds the 2000 Bubble

Source: Bloomberg
 15

Using the
average of four
different
valuations
metrics places
us at 99% above
historical
averages

Source: Doug Short, Advisor Perspectives

 16

S&P 500 index and median stock trades at high

valuation on all metrics except free cash flow yield

Source: ZeroHedge, 7 Reasons Why Goldmans Clients Are Very Worried About An Imminent Crash (09/09/2017)
 17
The Secret to Investment Success - DONT FOLLOW THE HERD!

Source: Bloomberg
 18

What do high current

valuations tell us
about the future?
19
 20

Green line seen 10 years before black line

Source: RecessionAlert
Data as of 2014 21
 22

Household equity ownership % of

financial assets paints a bleak
picture for forward returns

Source: Barry Bannister, Stifel Nicolaus Research

Its Happened Before!
23

Source: Bloomberg
 24

Stocks arent
the only asset
class with a
dismal future
 25

Research Affiliates Expected 10-Yr Returns (Core Assets)

Source: Research Affiliates

Research Affiliates Expected 10-Yr Returns (Core Assets) 26

Source: Research Affiliates

 27

Passion for passive$961bn inflows to passive funds since 09

Cumulative equity fund flows ($bn)

How to combat
this dismal
futureDont
follow the herd!

Source: BofAML Global Investment Strategy, EPFR Global.

 The Resurrection of Active Management
28

We often miss opportunity because its dressed in

overalls and looks like work
~Thomas Edison

A pessimist sees the difficulty in every opportunity; an

optimist sees the opportunity in every difficulty
~Winston S. Churchill

If opportunity doesnt knock, build a door

~Milton Berle
 29
How to Combat Dismal Buy-and-Hold Expected Returns
Active or Passive? It is Cyclical
30
The Buy-and-Hold Investor Sees Difficulty; The Active Investor Sees Opportunity

Source: Bloomberg
Active Management Doesnt Require Perfect Timing to Add Value

*Returns presented as compounded annual growth rates

Source: Bloomberg
When Is Active Management Most Useful?
33

Source: Bloomberg
 34

What Inning Are We in?

BEARS
BULLS
 35
14 of 15 variables suggest we are past the seventh-inning strength

Source: Dave Rosenberg, Charts With Dave (09/22/2017)

 Indicators We Track Confirm We Are in the Final Innings 36

Corporate profits as percent

of GDP peaked 12/31/2014

Source: Bloomberg

Auto sales peaked 11/30/2015

Source: Bloomberg
Central bankers try to tighten at paces that are 37

exactly right in order to keep growth and inflation

neither too hot nor too cold, until they dont get it
right and we have our next downturn. Recognizing
that, our responsibility now is to keep dancing but
closer to the exit and with a sharp eye on the tea
leaves.

~Ray Dalio, Central Banks Reversals Signal the End of One Era
and the Beginning of Another (07/06/17)
 38

Source: Bloomberg
There Have Been 13 Fed Hiking Cycles Since WW2, 9 Landed in Recession! 39

First Hike Last Hike Result

October 1950 May 1953 Recession
October 1955 August 1957 Recession
September 1958 September 1959 Recession
December 1965 September 1966 Soft landing
November 1967 June 1969 Recession
April 1972 September 1973 Recession
May 1977 March 1980 Recession
August 1980 December 1980 Recession
March 1983 August 1984 Soft landing
January 1987 May 1989 Soft Landing
February 1994 February 1995 Soft landing
June 1999 May 2000 Recession
June 2004 June 2006 Recession
December 2015 ??? ???
Source: Bloomberg
When Does the Fed Funds Rate Become Too Hot?
40

Source: Bloomberg, hat tip to Barry Bannister

 41

Source: Bloomberg

Current Cycle:
Low = -3%, High of 1.5% (Dec. est.)
Increase of 4.5%
 42

The Window of Vulnerability

Average Location of Peak in Terms of Cycles Length
Profits Auto
54.4% 66.2%
Peak in Terms of Innings
Profits Auto
6.0 7.4
 43

The Window of
Vulnerability *

Recession Start Date:

March 2019 to August 2019

Bull Market Top:

June 2018 to February 2019

*Note: Recession dates estimated using current peak in corporate profit margins and auto sales relative
to location within the business cycle. Bull market top estimated 6-9 months prior to recession start dates.
 How Much More Upside Is There? 44

According to Barry BannisterNOT MUCH!

Source: Barry Bannister, Fed Jun-2017 meeting - Jack be nimble, Jack be quick, 06/14/17 (Updated)
 45

Investment
Playbook

Defense Wins
Championships!
 46

Looking at the Last 14 Major Market Tops

Q. On the day
the market puts
in its final peak,
what percentage A. 1%
of stocks within B. 5%
the market are
already in a bear C. 10%
market (down D. >20
more than 20%)?
%
 Examination of Trading at Fourteen Peaks in the Dow Jones 47

BULL MKT TOP DAY % STOCKS @ NEW HIGHS % AT OR <2% OF NEW HIGHS % OFF 20% OR MORE % OFF 30% OR MORE

09/03/1929 2.30% 15.62% 31.84% 18.77%

03/10/1937 6.05% 21.34% 5.94% 1.06%
05/29/1946 8.59% 30.44% 6.30% 0.86%
04/06/1956 5.32% 23.36% 1.92% 0.42%
01/05/1960 1.60% 5.83% 23.25% 7.67%
12/13/1961 3.56% 11.83% 25.29% 11.60%
02/09/1966 9.66% 19.04% 9.52% 2.68%
12/03/1968 9.43% 20.12% 9.51% 2.36%
01/11/1973 5.30% 11.82% 34.22% 20.51%
09/21/1976 10.97% 22.88% 21.65% 10.09%
04/27/1981 7.09% 15.18% 28.01% 9.39%
08/25/1987 6.23% 15.23% 17.37% 7.44%
07/16/1990 5.35% 18.11% 37.31% 22.74%
01/14/2000 3.54% 6.31% 55.33% 32.45%
10/09/2007 10.77% 11.03% 26.51% 16.51%
AVERAGE 6.38% 16.54% 22.26% 10.97%
Source: Lowry Resource Corp., The Warning Signs of Major Market Tops (2014)
 48

Market Tops
Are a Process,
Not an Event
 49
The 2000 Market Topping Process

Source: Bloomberg
 50
The 2007 Market Topping Process

Source: Bloomberg
 51
Current Market Internals

Source: Bloomberg
When to Stop Dancing and Start Running
52

Source: Bloomberg
Its only when the tide goes out that you learn who 53

has been swimming naked ~Warren Buffett

Source: Bloomberg
 54

Summary and Conclusion

1. Markets Extreme Valuations

2. Dismal Expected Returns of the Next Decade

3. The Case for Active Management